Экзамен зачет учебный год 2023 / Class_8

conclude that they will do better by settling for an out-of-pocket payment than by trying the case and winning, let alone taking the risk of losing.”34

Four of the eight 1980–2005 securities lawsuits in which outside directors made out-of-pocket payments fit this low-or-no-insurance “Can’t Afford to Win” pattern; a fifth might do so.35 However, this scenario should not be a substantial concern for outside directors today, assuming a public company has a well-counseled board. Virtually all U.S. public companies now carry D&O insurance,36 and the vast majority have insurance at levels that should cover litigation expenses with enough left over to fund a decent settlement. Furthermore, companies can now purchase insurance designed to preserve outside directors’ coverage irrespective of misconduct that will permit insurers to deny coverage to the inside directors.

With an insolvent company that has D&O coverage sufficient to cover legal expenses and fund a decent settlement, settlements are likely to occur within the D&O policy limits and leave directors’ personal assets intact. Plaintiffs will accept such terms to avoid the risk and expense of going to trial and to ensure that the proceeds of the D&O policy—often the sole remaining “deep pocket”—are not depleted by directors’ legal expenses. This settlement dynamic, however, is not inevitable. For securities lawsuits, which are the primary source of risk for outside directors of U.S. public companies, a plaintiff can, in a “Perfect Storm” scenario, credibly threaten to go to trial and collect damages from the outside directors personally that might bankrupt them. In response, the outside directors should be willing to

settle by making out-of-pocket payments that are less than their expected loss if they were to go to trial.37

For outside directors, in simplified form, the elements of a Perfect Storm are: (i) the company is insolvent and the D&O insurance available to cover all directors is less than the lead plaintiff’s estimate of the net present value of going to trial; (ii) the case against the outside directors involves either a claim for prospectus misdisclosure under § 11 of Securities Act of 1934, for which the operative standard is negligence,38 or an unusually strong claim based on disclosures outside the public offering context, which involve a higher “scienter” standard of culpability; and (iii) there must be defendants with sufficient wealth, aligned with culpability, so that the plaintiffs can expect to recover more by going to trial than by settling within D&O policy

34.Outside Director Liability, supra note 1 at 1109.

35.On the actual cases and for a broader examination of the “Can’t Afford to Win” scenario, see id. at 1109–10.

36.TILLINGHAST TOWERS PERRIN, UNDERSTANDING THE UNEXPECTED: 2004 DIRECTORS AND OFFICERS SURVEY REPORT 25 (2004) (reporting that 100% of publicly held U.S. firms responding to the survey had D&O insurance).

37.On the “Perfect Storm” scenario, see Outside Director Liability, supra note 1, at 1113–18.

38.15 U.S.C. § 77(k) (2006).

limits.39 Four (possibly five) of the securities lawsuits where outside directors made personal payments between 1980 and 2005 were Perfect Storms or came close to being so, including Enron and WorldCom.

With Enron and WorldCom, an additional element of the settlements captured attention. In both instances, a public-minded plaintiff made it a priority to collect directly from the outside directors so as to send a message to future boards. In the WorldCom settlement, the New York State Common Retirement Fund, as lead plaintiff, insisted that the outside directors pay some damages out of their own pocket in order to send “a strong message to the directors of every publicly traded company that they must be vigilant guardians for the shareholders they represent.”40 The Enron settlement likely reflected a similar motive on the part of the lead plaintiff, The Regents of the University of California, although plaintiffs’ counsel was more vocal than the lead plaintiff in so stating the objectives.41

The Enron and WorldCom securities fraud settlements were quickly heralded as “legendary.”42 John Coffee, a Columbia law professor, said the “explicit agenda of requiring a personal contribution ha(d) traumatized outside directors.”43 It is doubtful, however, whether future lead plaintiffs will be able to adopt successfully the negotiating stance of the Enron and WorldCom lead plaintiffs unless conditions approaching a Perfect Storm are present. To illustrate, a “send a message” strategy is only likely to be feasible if the company is insolvent. In a securities case, the company is primarily liable for all damages, and the case is easier to prove against the company than against outside directors.44 Moreover, a company is usually bound to indemnify the outside directors for any damages they might be liable to pay. Assuming a company offers to pay damages in full in a settlement or after a trial, a lead plaintiff will be hard pressed to justify prolonging the case by demanding that outside directors be held partly accountable, particularly since lead plaintiffs owe duties to act in the interests of the class.

Even if public pension funds or other institutional investors were to seek out-of-pocket payments from outside directors with some frequency, a market or political counter-reaction could restore the status quo. When

39.It is not necessary that the outside directors themselves be wealthy. Plaintiffs may choose to keep them in a case, perhaps at relatively little extra cost, where the primary recovery would come from other defendants.

40.Press Release, Office of the New York State Comptroller, Hevesi Announces Historic Settlement, Former WorldCom Dirs. to Pay from Own Pockets (Jan. 7, 2005), http://www.osc.state.ny.us/press/releases/jan05/010705.htm.

41.See Ben White, Former Directors Agree to Settle Class Actions; Enron, WorldCom Officials to Pay Out of Pocket, WASH. POST, Jan. 8, 2005, at E1 (quoting plaintiffs’ counsel, William Lerach, saying the settlement will “send a message”).

42.Roger Eabee, Director Shortage? No Way, FIN. EXECUTIVE, May 2005, at 38.

43.John C. Coffee, Jr., Hidden Issues in ‘WorldCom,’ NAT’L L.J., Mar. 21, 2005, at 13.

44.See Outside Director Liability, supra note 1, at 1080–81.

concerns about directors’ legal risks have emerged in the past in the U.S., legal and market responses have brought the risk down again. The rise of securities fraud lawsuits in the 1960s fostered the liberalization of indemnification rules under corporate law and the widespread purchasing of D&O insurance.45 Also noteworthy was the legislative response to the famous Smith v. Van Gorkom case, in which the Delaware Supreme Court ruled that outside directors had failed to use sufficient care in approving a merger and awarded damages in excess of the D&O insurance coverage.46 Delaware and state legislatures nationwide enacted statutes that permitted companies to amend their charters to protect outside directors from liability for breach of the duty of care.47 The efforts to reduce director exposure in the Private Securities Litigation Reform Act of 1995 and the Securities Litigation Uniform Standards Act of 1998 offer further examples of a legislative reaction to fears of director liability.48 Should outside directors begin to face serious liability risks in the wake of the WorldCom and Enron settlements, a similar legislative correction might well occur.

One way to place recent U.S. developments into perspective is by examining how matters work elsewhere. We will do this now. From an American perspective, this exercise will show that the United States is exceptional in its level of litigation. Lawsuits involving directors are less common in other countries because losing litigants are often required to pay at least part of the successful party’s legal expenses, lawyers cannot claim attorneys' fees in derivative litigation, US-style contingency fees are not permitted, and class actions are difficult to launch. There are, however, various key common themes across borders:

(i)Outside directors of public companies face only a remote chance of paying out of their own pocket for oversight failures;

(ii)Risk exists primarily when the company has suffered an acute financial crisis, often leading to bankruptcy;

(iii)Lack of protection by D&O insurance (including low policy limits and policy exclusions) increases the likelihood of an out-of-pocket payment;

(iv)The “send a message” scenario does pose dangers for outside directors, but often it is regulators rather than private litigants who are seeking to make a point; and,

45.Bernard S. Black, Brian R. Cheffins & Michael Klausner, Liability Risk for Outside Directors: A Cross-Border Analysis, 11 EUR. FIN. MGMT. 153, 161 (2005).

46.488 A.2d 858, 864 (Del. 1985). The acquirer paid the judgment in excess of available D&O coverage on behalf of the outside directors but required each director to donate 10% of this amount to charity. See Roundtable Discussion: Corporate Governance, 77 CHI.-KENT L. REV. 235, 238 (2001) (quoting Robert Pritzker, a controlling shareholder of the acquiring company).

47.On the amendments made to corporate law, see supra note 32 (discussing adoption of § 102(b)(7) of Delaware’s corporate legislation and the corresponding provision in the MBCA).

48.Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (1995); Securities Litigation Uniform Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227; see HAMILTON (2000), supra note 24, at 562–74 (summarizing the key aspects of the two Acts).

(v) Political and market reactions often emerge to reduce the risk of out- of-pocket payments, when it arises.

IV. United Kingdom

A. Outside Directors in the U.K.

In a typical British public company, non-executive directors make up about half of the board, compared to the two-thirds ratio (or more) that is common today in the U.S.49 U.K company law, like U.S. law, does not make a formal legal distinction between the duties of executive and non-executive directors. Instead, all directors generally bear equal legal responsibility for company actions.50 Recent case law suggests, though, that the English judiciary has recognized the part-time role that non-executives play in a public company and is prepared to adjust their duties accordingly.51

Despite judicial recognition of the distinctive role non-executive directors play, concerns about liability risk have been growing recently in Britain.52 A catalyst for this concern was a lawsuit brought by Equitable Life, a major British insurer that nearly went bankrupt in the late 1990s. The old board was replaced after the debacle, and the new board sued the auditor and fifteen former directors, including nine non-executives, for damages exceeding £3 billion.53 The non-executive directors sought to have the claim

49.DEPARTMENT OF TRADE AND INDUSTRY, THE CURRENT POPULATION OF NON-EXECUTIVE

DIRECTORS 4–17 (2003) (Eng.), available at http://www.dti.gov.uk/cld/ non_exec_review/pdfs/finalcensus.pdf (discussing U.K. board composition); DELOITTE & TOUCHE, BOARD STRUCTURE, DISCLOSURE AND NON-EXECUTIVE DIRECTORS’ FEES 15–17 (2003) (same); Sanjai Bhagat & Bernard Black, The Non-Correlation Between Board Independence and LongTerm Firm Performance, 27 J. CORP. L. 231, 238 (2002) (discussing U.S. board composition); Ira M. Millstein & Paul. W. MacAvoy, The Active Board of Directors and Performance of the Large Publicly Traded Corporation, 98 COLUM. L. REV. 1283, 1285–88 (1998) (same).

50.Dorchester Fin. Co. Ltd. v. Stebbing, [1989] B.C.L.C. 498 (Ch.); COMPANY LAW REVIEW

STEERING GROUP, MODERN COMPANY LAW FOR A COMPETITIVE ECONOMY: DEVELOPING THE

FRAMEWORK ¶ 3.137 (2000), available at http://www.dti.gov.uk/cld/claw_2_3.pdf; PALMER’S COMPANY LAW ¶ 8.050 (Geoffrey Morse et al. eds., 25th ed. 1992).

51.See Equitable Life Assurance Soc’y v. Bowley, [2003] EWHC (Comm) 2263, [35]-[41], (2004) 1 B.C.L.C. 180, 188–89 (“There is a considerable measure of agreement about the duty owed in law by a non-executive director to a company. In expression it does not differ from the duty owed by an executive director but in application it may and usually will do so.”); Re Cont’l Assurance Co. of London Plc, [2001] B.P.I.R. 733, 850 (Ch.) (“I accept that the managing director of a company. . .has a general responsibility to oversee the activities of the company, which presumably includes its accounting operations. But I do not think that those responsibilities go as far as to require the non-executive directors to overrule the specialist directors, like the finance director, in their specialist fields.”).

52.CHARKHAM (2005), supra note 16, at 356; Maija Pesola, Raw Deal for IT Non-Executives, FIN. TIMES, July 4, 2005, at 20; Bob Sherwood, Non-Executives Worry Over Legal Liabilities, FIN. TIMES, June 30, 2003, at 4.

53.Tessa Thorniley & Philip Aldrick, Equitable Life Sues Directors for £3bn, TELEGRAPH, Oct. 18, 2003, at 1 (identifying the nine non-executive directors and the six executive directors who were named as defendants).

against them dismissed, but this application failed.54 Equitable had D&O coverage of £5 million, which was insufficient to cover the directors’ legal expenses, let alone potential damages.55 The trial began in 2005 but after the case went badly for Equitable it agreed to drop its claim and pay the legal expenses of the non-executive directors.56 Despite this outcome, and despite the fact that Equitable Life was a mutual society owned by its policyholders rather than a publicly quoted company owned by its shareholders, the litigation was often cited as the sort of nightmare that would make the boardrooms of public companies tougher to fill.57 We discuss the case in more detail below.

In the remainder of this Part, we discuss duties owed by U.K. directors to their companies (III.B), enforcement of directors’ duties by the company (III.C), direct suits by shareholders (III.D), shields against out-of-pocket liability (III.E), and the impact of insolvency on director liability (III.F).

B. Duties Owed by Directors to the Company

Under venerable case law authorities, U.K. directors owe several “core” duties to their companies. One is an obligation to act in the best interests of the company.58 The typical scenario in which this duty is breached involves self-dealing, a form of misconduct in which outside directors of public companies are unlikely to engage. Directors acting with pure motives can, however, breach a related obligation not to use their powers for an “improper collateral purpose.”59 In theory, directors can be liable to their company for any loss the company suffers as a result of such a misuse of power. The

54.Equitable Life Assurance Soc’y v. Bowley, [2003] EWHC (Comm) 2263, [2004] 1 B.C.L.C. 180.

55.Antonia Senior, Equitable Case Fuels Directors’ Insurance, TIMES (London), Sept. 29, 2003, at 23; Nikki Tait & Andrea Felsted, Bad Policies: Counting the Costs of the Equitable Case in Life Savings and Reputations, FIN. TIMES, Dec. 5, 2005, at 21 (“It was not until early 2003, following an arbitration, that (the ex-directors) finally secured a £5 million pool – although it was completely inadequate.”)

56.On the settlement terms provided to eight of the nine non-executives, see Christine Seib,

Equitable Drops the Last of its £3.75bn Legal Claim, TIMES (London), Dec. 3, 2005, at 60; Tait & Felsted (2005), supra note 55. Equitable Life had settled earlier with the ninth non-executive director on the basis that each side would bear their own costs, but he had defended himself in court and available D&O insurance should have been sufficient to cover his minimal out-of-pocket costs. Christine Seib, Deals Likely as Equitable Drops Claim, TIMES (London), Oct. 4, 2005, at 44.

57.Sandra Speares, Does Non-Executive Mean Uninsurable?, LLOYD’S LIST, Oct. 26, 2005, at 6; Tait & Felsted (2005), supra note 55. On Equitable Life’s status as a mutual society and the distinction between mutuals and public companies, see Christopher Brown-Humes, Survival Depends on Differentiation, FIN. TIMES, Mar. 10, 1998, at 1.

58.In Re Smith & Fawcett, Ltd., [1942] Ch. 304.

59.Regentcrest Plc v. Cohen, [2001] 2 B.C.L.C. 80, 105; see Richard C. Nolan, The Proper Purpose Doctrine and Company Directors, in THE REALM OF COMPANY LAW 1, 7–10 (Barry A.K. Rider ed., 1998) (explaining that directors, independent from their subjective honesty or integrity, must exercise their powers only for permissible purposes). On the sort of cases involved, see HANNIGAN (2003), supra note 17, at 233.

remedy typically sought, however, is an order unwinding the challenged transaction, not damages.60

U.K. directors also owe to their companies duties of care, skill, and diligence. This duty is similar in spirit to the U.S. duty of care, but the culpability standard is roughly one of negligence rather than gross negligence as applied in the U.S.61 There is also no formal doctrine of judicial abdication in applying the duty, akin to the U.S. business judgment rule.62 On the other hand, English judges have been reluctant to second guess corporate decision-making and have refrained from holding directors liable for mere errors of judgment.63

Over the past couple of decades, English judges have drawn upon a provision governing claims against directors of insolvent companies for “wrongful trading” (continuing to operate a company once insolvency is inevitable) to toughen common law standards.64 For instance, while older decisions merely required directors to exhibit the skill reasonably expected of persons of equivalent knowledge and experience, more recent cases require them to act in a manner reasonably expected of persons performing the duties in fact undertaken.65 Similarly, while a director traditionally was not obliged to give continuous attention to the company, a director is now obliged to remain informed about a company’s affairs.66

Also noteworthy is that while older cases indicated that directors, in the absence of grounds for suspicion, were entitled to rely on fellow directors and on officers of the company, newer decisions emphasize that delegation to others does not absolve a director from the duty to supervise the delegated

60.HANNIGAN (2003), supra note 17, at 242; Nolan (1998), supra note 59, at 27–29.

61.In the U.K., see In Re City Equitable Fire Ins. Co., [1925] Ch. 407, 427–28; PALMER’S COMPANY LAW, supra note 50, ¶ 8.409. In the U.S., see Aronson v. Lewis, 473 A.2d 805, 812 (Del. 1984).

62.PAUL DAVIES, INTRODUCTION TO COMPANY LAW 156–57 (2002).

63.See PALMER’S COMPANY LAW, supra note 50, ¶ 8.409 (citing Lagunas Nitrate Co. v. Lagunas Syndicate, (1899) 2 Ch. 392).

64.The relevant provision, Insolvency Act, 1986, c. 45, § 214(4), reads:

[T]he facts which a director of a company ought to know or ascertain, the conclusions which he ought to reach and the steps which he ought to take are those which would be known or ascertained, or reached or taken, by a reasonably diligent person having both—

(a)the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by that director in relation to the company, and

(b)the general knowledge, skill and experience that that director has.

65.Compare In Re City Equitable Fire Ins. Co., [1925] Ch. 407, 428, with Norman v. Theodore Goddard, [1991] B.C.L.C. 1028, 1030–31.

66.On the old law, see Re City Equitable Fire Ins. Co., [1925] Ch. 407, 429. On the new standards, see Re Barings Plc (No. 5), (2000) 1 B.C.L.C. 523, 535–36; Re Westmid Packing Services (No.2), (1998) 2 All E.R. 124, 130; Equitable Life Assurance Soc’y v. Bowley, [2003] EWHC (Comm) 2263, [39]-[41], (2004) 1 B.C.L.C. 180, 189.

function.67 Hence, even when a director has no reason to suspect that reliance on fellow board members or corporate officers is misplaced, a director might still be in breach of duty if he fails to monitor and control what is going on.68 On the other hand, the judiciary has recognized that the competence of a director should be assessed by reference to the role assigned to him. As a result, the duties and responsibilities of an outside director of a U.K. public company will be judged by what could be reasonably expected of an individual serving in that capacity rather than the more exacting standards likely to apply to an executive director.69

In addition to duties owed to their companies under the common law, U.K. directors must comply with numerous obligations imposed by the Companies Act 1985, the U.K. analogue to U.S. state corporate statutes. In general, infringements of the Companies Act 1985 do not provide a foundation for civil suits.70 Still, the Act does provide for redress against directors in some circumstances. For instance, if a company makes an improper dividend payment to shareholders, directors who knew or had reasonable grounds for believing it was improper are liable to the company for the improper payment.71 Due to the “reasonable grounds” foundation for liability, a careless non-executive could became liable without knowing the dividend was improper. This may be a tougher standard than under U.S. corporate law, where outside directors are liable for improper dividends but state legislation typically offers protection if they believed in good faith that the company had sufficient assets to justify the dividend.72

Another distinction between U.K. and U.S. corporate law deserves emphasis. In the U.S., companies can, and typically do, adopt charter provisions that eliminate directors’ liability for breach of fiduciary duty for all but intentional or self-serving conduct.73 In Britain, shareholders can excuse a breach that does not involve misappropriation of corporate assets or

67.Re Barings Plc (No. 5), (1999) 1 B.C.L.C. 433, 489; PALMER’S COMPANY LAW, supra note 50, ¶¶ 8.411.1–8.411.2.

68.Re Landhurst Leasing Plc (1999) 1 B.C.L.C. 286, 346; Richard C. Nolan, The Legal Control of Directors’ Conflicts of Interest in the United Kingdom: Non-Executive Directors Following the Higgs Report, 6 THEORETICAL INQ. L. 413, 452 (2005).

69.Re Barings Plc. (No. 5), (2000) 1 B.C.L.C. 523, 535; Re Equitable Life Assurance Soc’y v. Bowley, [2003] EWHC (Comm) 2263, [35], (2004) 1 B.C.L.C. 180, 188; Re Barings Plc. (No. 5), (1999) 1 B.C.L.C. 433, 483–84.

70.On judicial reluctance to imply civil remedies for the breach of statutory duties, see Lonrho Ltd. v. Shell Petroleum Co. Ltd., [1982] A.C. 173 (H.L.).

71.Companies Act, 1985, c. 6, § 277. See, e.g., Bairstow v. Queens Moat Houses Plc., [2001] EWCA (Civ) 712, [29]-[36] (inside directors of a public quoted company were held liable for £26.7 million after seemingly proper dividend payments turned out to be illegal because of accounting irregularities).

72.On director liability for improper dividends in the U.S., see R. FRANKLIN BALOTTI & JESSE

A. FINKELSTEIN, THE DELAWARE LAW OF CORPORATIONS AND BUSINESS ORGANIZATIONS § 5.32 (2d ed. 2005); JAMES D. COX, THOMAS LEE HAZEN & F. HODGE O’NEAL, CORPORATIONS § 20.23 (1997).

73.See supra note 32 and accompanying text.

other conduct amounting to “fraud” on a case-by-case basis.74 The Companies Act 1985 renders void, however, a provision in the corporate constitution that exempts directors from liability for breach of duty.75

At the time of this writing, a massive 885-clause Company Law Reform Bill was before Parliament that would substantially amend current companies legislation.76 A key innovation in the Bill is a statutory statement of directors’ main duties.77 According to the Government, the general intention is to clarify rather than change the law.78 There has been much speculation that a clause that obliges directors to consider the interests of employees and the impact of the company’s operations on the community and the environment could lead to more lawsuits against directors.79 Such fears are likely misconceived. The relevant obligations would not be directly owed to stakeholder groups. Instead, their interests would merely be part of a broader duty that directors owe to the company, and stakeholder groups would have no right to sue in the company’s name for an asserted breach.80 The proposed amendments should therefore not increase significantly the risks faced by non-executive directors.

C.Enforcement of Breaches of Duty by the Company (including Derivative Litigation)

Formal liability is one thing; enforcement is another. Launching a suit under U.S. corporate law alleging directors have breached duties owed to the

74.Regal (Hastings) Ltd. v. Gulliver, (1942) 1 All E.R. 378, 389 (H.L.). Though it is well accepted that shareholders have the power to waive directors’ liability for breach of duty, it is questionable whether there is an English case directly on point. R.J.C. Partridge, Ratification and the Release of Directors from Personal Liability, 46 CAMBRIDGE L.J. 122, 123–25 (1987). On which breaches of duty can be ratified by shareholders under U.K. company law, see Burland v. Earle, [1902] A.C. 83, 93; Atwool v. Merryweather, [1867] L.R. Eq. 464; Brenda Hannigan,

Limitations on a Shareholder’s Right to Vote—Effective Ratification Revisited, 2000 J. BUS. L. 493.

75.Companies Act, 1985, c. 6, § 309A(2).

76.Company Law Reform Bill, 2005, H.L. Bill [34], available at http://www.publications.parliament.uk/pa/ld200506/ldbills/034/2006034.pdf [hereinafter H.L. Bill [34]].

77.Id. at §§ 154–61.

78.Company Law Reform Bill Explanatory Notes, 2005, H.L. Bill [34–EN], ¶ 301, available at http://www.publications.parliament.uk/pa/ld200506/ldbills/034/2006034.pdf [hereinafter H.L. Bill [34–EN]]; see also H.L. Bill [34], § 154(3) (saying that the codified duties are based on, and have effect in place of, certain common law and equitable rules). The Government has acknowledged its intention to change the law in certain respects with conflicts of interest. H.L. Bill [34 E-N], ¶ 302. Since this article focuses on directors who have acted in good faith, these changes to the law will not be analyzed here.

79.H.L. Bill [34], § 156(1), (3); Jean Eaglesham & Christopher Adams, Fears Weight of Law Will Fall on Directors, FIN. TIMES, Feb. 3, 2006, at 3; Robert Watts, ‘This Bill Will Discourage People from Becoming a Director,’ TELEGRAPH, Jan. 29, 2006, at 6.

80.H.L. Bill [34], § 154(1); see PAUL L. DAVIES, GOWER AND DAVIES’ PRINCIPLES OF

MODERN COMPANY LAW 377–79 (7th ed. 2003) (describing a similarly structured draft clause in DEPARTMENT OF TRADE AND INDUSTRY, MODERNISING COMPANY LAW, 2002, Cm. 5553-II, at 112–13, available at http://www.dti.gov.uk/companiesbill/volume2.pdf).

corporation is straightforward, but charter amendments eliminating directors’ liability help to ensure outside directors’ personal assets are rarely at risk. U.K. directors lack similar liability exemptions, but procedural factors ensure that public companies rarely sue their directors.81

In most instances, directors of U.K. companies owe their duties to the company and the company alone; the company will be the “proper plaintiff” in a potential suit.82 While derivative suits in the U.S. often provide a viable platform for such litigation, the picture is quite different in Britain.83 Under U.K. company law, the board normally decides when a company will sue.84 So long as non-executive directors remain in office and relations in the boardroom are cordial, a suit against them is highly unlikely.85 The situation can change when things have taken a bad turn at a company and the former directors have departed, since the new directors will be less constrained by a sense of collegiality and might launch proceedings. The Equitable Life litigation illustrates this point: the post-crisis board decided to take tough action against those allegedly responsible for the insurer’s plight, including both executive and non-executive directors.86 Nevertheless, this type of case will be the exception rather than the rule.

The English judiciary has recognized that leaving the decision to sue purely in the hands of the board may lead to serious wrongdoing going unaddressed and has crafted limited exceptions where shareholders can sue for a breach of duty by directors through derivative litigation. However, these exceptions—for “fraud on the minority,” ultra vires conduct, and acts requiring a vote by a special majority of shareholders87—will rarely apply in cases involving outside directors of public companies. Consider fraud on the

81.On the rarity of such litigation, see SIMON DEAKIN & ALAN HUGHES, DIRECTORS’ DUTIES: EMPIRICAL FINDINGS 15–16 (1999).

82.On whom directors owe duties to, see Peskin v. Anderson, (2000) 2 B.C.L.C. 1, 14–15 (Ch.); and Percival v. Wright, (1902) 2 Ch. 421, 423–25. On the “proper plaintiff” principle, see Prudential Assurance Co. Ltd. v. Newman Indus. Ltd. (No. 2), (1982) 1 All E.R. 354, 357. Due to 1999 civil procedure reforms, in English civil trials the “plaintiff” is now referred to as a “claimant.” ANDREWS, supra note 19, at 26. We will, for consistency, use the term “plaintiff” throughout this article.

83.Anthony J. Boyle, The Private Law Enforcement of Directors’ Duties, in CORPORATE

GOVERNANCE AND DIRECTORS’ LIABILITIES: LEGAL, ECONOMIC AND SOCIOLOGICAL ANALYSES ON CORPORATE SOCIAL RESPONSIBILITY 261, 276–78 (Klaus J. Hopt & Gunter Teubner eds.,

1985).

84. Mitchell & Hobbs (UK) Ltd v. Mill, (1996) 2 B.C.L.C. 102 (Q.B.); Breckland Group Holdings Ltd. v. London & Suffolk Props. Ltd., [1989] B.C.L.C. 100 (Ch.); HANS C. HIRT, THE

ENFORCEMENT OF DIRECTORS’ DUTIES IN BRITAIN AND GERMANY: A COMPARATIVE STUDY WITH PARTICULAR REFERENCE TO LARGE COMPANIES 79–80 (2004).

85.Colin Baxter, Demystifying D&O Insurance, 15 OXFORD J. LEGAL STUD. 537, 538–39 (1995); Hans-Christoph Hirt, The Review of the Role and Effectiveness of Non-Executive Directors: A Critical Assessment with Particular Reference to the German Two-Tier Board System: Part 2, 14 INT’L COMPANY & COM. L. REV. 261, 266 (2003).

86.See supra note 53 and accompanying text.

87.HIRT (2004), supra note 84, at 143–54.

minority, the most important exception.88 Misconduct by outside directors will probably involve failures to exercise care and skill rather than dishonesty or self-dealing and thus will not constitute “fraud.”89 Moreover, a derivative suit can only proceed if there is “wrongdoer control,” which requires that the defendants own enough shares and exercise sufficient influence to dictate voting outcomes.90 Non-executive directors of U.K. public companies rarely own a substantial percentage of the outstanding shares, so a shareholder generally cannot meet this standard.91

Even if the “fraud on the minority” exception is available, the time, hassle, and expense involved will discourage the launching of a suit. One hurdle is that a shareholder seeking to litigate on behalf of a company must establish at a preliminary hearing that the company is likely to be entitled to the relief claimed and that the action involves an exception to the usual ban on derivative suits.92 Only if leave is granted can a trial on the merits follow.

A shareholder can incur large legal bills applying for leave to sue and potentially further expense if the matter goes to trial. Offloading the risk on to lawyers is theoretically possible since plaintiffs in the U.K. can enter into conditional fee agreements under which a lawyer can agree to a “no win, no fee” arrangement.93 For lawyers, however, the maximum “upside” under such an agreement is 100% of hourly fees.94 This compares poorly with the

88.On the significance of the “fraud on the minority” exception, see PALMER’S COMPANY LAW, supra note 50, ¶ 8.813. Because of statutory reforms altering the effect of transactions falling outside a company’s powers, the ultra vires exception has been rendered essentially irrelevant in practice. Id. at ¶ 8.812. With respect to the “special majority” exception, U.K. companies’ legislation only requires a supermajority vote in a narrow range of circumstances, such as the amendment of the corporate constitution, the alteration of a company’s core financial structure, or the ratification of transactions beyond a company’s powers. Id. at ¶ 8.812.1; HANNIGAN (2003), supra note 17, at 461.

89.An exception is where a negligent exercise of managerial power by directors causes the directors to benefit at the expense of the company. Daniels v. Daniels, [1978] Ch. 406. While the concept of fraud is not well-specified, it is widely acknowledged that it encompasses the misappropriation of money, property, or advantages which belong to the company. PALMER’S COMPANY LAW, supra note 50, ¶ 8.814.

90.Birch v. Sullivan, (1957) 1 W.L.R. 1247 (Ch.). Control does not require ownership of a strict majority of shares. Prudential Assurance Co. Ltd. v. Newman Indus. Ltd. (No. 2), (1982) 1 All E.R. 354, 364.

91.BRIAN R. CHEFFINS, COMPANY LAW: THEORY, STRUCTURE AND OPERATION 465 (1997); see also Hans C. Hirt, The Company’s Decision to Litigate Against Its Directors: Legal Strategies to Deal with the Board of Directors’ Conflict of Interest, 2005 J. BUS. L. 159, 171 (“[De] jure control of large companies is generally uncommon in England. However, directors of such companies may have de facto control, for example, as a result of poor attendance at shareholders’ meetings in conjunction with the proxy voting system.”).

92.Civil Procedure Rules, 1998, S.I. 1998/3132, art. 19.9, ¶¶ 1–3; HIRT (2004), supra note 84, at 125–27.

93.A. J. BOYLE, MINORITY SHAREHOLDERS’ REMEDIES 37, 59 (2002); HIRT (2004), supra note 84, at 132–34.

94.U.S.-style contingency fees, where a lawyer receives a percentage of any judgment or settlement, remain unlawful in the U.K. Neil Andrews, Note, Common Law Invalidity of